Tuesday, November 29, 2005

Legacy costs

By now, we all know that most nations face a nasty pension crisis in the not so distant future. For some corporations, like GM, that future is now. Yet, it is hard to find creative and serious policy debates on how to tackle this huge problem.

Sure, many people have put forward what can only be called the "Scrooge" alternative: longer working lives and/or lower benefits. These may (specially the former) have some merit, but they do seem rather unfair, notably to older workers.

In the case of firms facing bankruptcy, the solution (at least in the U.S.) has been fobbing off pension liabilities to the government's Pension Benefit Guarranty Corp., which takes over the pension plan (but has no claim on the sponsoring firm's assets). For many firms --take Delphi as a good example--the ability to ditch pension liabilities is very attractive. Unless the system is reformed, this trend threatens to snowball massively (the government already projects that the PBGC's deficit at over 100 billion dollars).

I want to make it clear that many firms have to go under and eliminate liabilities such as these to survive. After all, large pension deficits increase borrowing costs and restrict borrowing facilities, besides making labor relations very tense.

For this reason, I'm very pleased that Dick Berner of Morgan Stanley has put forward a serious proposal to deal with this problem. It basically involves having the PBGC fund the outstanding net pension liabilities in exchange for having the firm cover this cost (with interest) over a certain period of time. It would also give the PBGC priority over other creditors and force firms to fully fund new pension/retirement promises.

I like this idea, which (as noted by the author) has parallels in the S&L bailout and, to a degree, on the Brady-bond restructuring of Third World debt. While these plans involve upfront costs for society--no getting around that--they work quite well in the long-run.

However, I do believe it doesn't go far enough. For one, it doesn't address a very big issue: firms with large pension liabilities are often badly managed and also need to reduce current labor costs. This calls for greater involvement of workers in corporate governance, as Brad De Long has pointed out, perhaps through equity-for-concesions swaps. This sounds fairly obvious, but they don't seem to have worked well in the airline industry (I don't know the details too well).

Friday, November 18, 2005

What the hell are the markets thinking?

After months of denial, yesterday I finally accepted a very basic point: I can’t explain anything anymore.

To do my job, I need to develop a good idea of global economics and politics and how they translate into asset prices in order to develop successful investment strategies. But right now I see a breakdown between “objective” reality and its reflection in the Matrix-like world of financial markets.

This may sound extreme, but bear with me. At first glance, things are not going badly. The world economy is growing at a very good rate and it has proved very resilient to the recent shock in energy and commodity prices. As a result, stock markets the world over are doing great and long-term interest rates are still at or near the lowest levels in decades.

Yet, the political superstructure on which economic prosperity depends is crumbling.

The United States is, for all practical purposes, does not have a functional government. I say this with amazement, dismay and consternation. George Bush has lost even the limited grasp of reality he had and has no idea how to correct his past mistakes, which are rapidly eroding his authority, let alone set a coherent policy agenda. The less we can say about his second in command, the better. And let’s not forget that his party is in disarray, while the opposition does not have the standing, intelligence or leadership to defend the nation’s vital interests.

And we have three more years of this to look forward to.

Looking abroad, things are not much better. Western Europe’s heads of state are discredited (Chirac, Berlusconi and now, to some extent, Blair) or inexperienced (i.e. Merkel). Japan’s Koizumi seems like a strong leader, but he leads a timid nation. Russia is ruled by a thug and China has still not developed a strong, effective voice in international affairs.

In addition, many of the world’s leading multilateral organizations, such as the U.N., the World Bank and the WTO, seem paralyzed or ineffectual.

Basically, this implies that if a crisis that requires effective coordination arises, we probably won’t get it, with predictably negative consequences.

Yet, the bond market isn’t worried one bit: risk spreads are actually below the average of the past 15 years (the BAA/10 yr-Treasury stands at 184 basis points, vs. an average of 208 basis points). Stocks are rising and emerging market assets are once again in full bloom.

Even if the probability of a nasty, unforeseen crisis is very low, the damage would be severe given the above conditions. My impression is that asset prices are not pricing this in.

Why? I have no idea.

Oh, and have I mentioned that GM is about to go bankrupt? Even though this firm is a shadow of its former self, it is still huge by any measure except market value. When a CEO writes to all employees to categorically state that the firm won’t go bankrupt, a Chapter 11 filing is a sure thing (unless the aforementioned CEO is quickly fired and replaced by someone who can act correctly and decisively).

Wednesday, November 16, 2005

Evangelical Economics

Say it ain't so! But, yes, economics can be put to use to promote the aims of religious conservatives.

Marginal Revolution offers this example: a study that finds that teenage girls engage in less risky sex if the "cost" of abortions is raised by the adoption of parental notification laws.

Since reducing risky sex by making abortion costlier is also associated with lower rates of teenage pregnancy and STI, the authors clearly approve of parental notification laws.

Indeed, the authors do discover the very obvious point that teenagers do respond to incentives. In fact, using their logic, why don't we go all the way and make abortion illegal again?

I'm not getting into THAT argument. I just want to make the obvious point that there are other, more effective, ways of reducing the incidence of STI's/pregnancy among teenagers: mandatory, realistic and rigorous sexual education and easy access to contraceptives. Áfter all, this works fine in Western Europe, where abortion and teenage pregnancy rates are orders of magnitude lower than in the United States.

Yet, this alternative ignored, both by the authors and by politicians, even though it's more humane than the return to the days of coathanger abortions.

But that's exactly the problem with fundamentalists. They can't distinguish between sinful behavior. In other words, to them fornication is just as bad as murder.

Hence, they'll resist making contraceptives more accesible to teenagers and proving them with decent sex-ed, even though that would probably make abortion much rarer than straight prohibition ever could. Hence, they oppose making emergency contraception available over the counter. Hence, they oppose a vaccine against the sexually-transmitted HP virus that kills thousands of women each year.

In a way, these people are just as vile as their Islamic cousins.

Thursday, November 03, 2005

Baseball and hateful partisans

Yes, nothing gets my goat more than blinkered ideologues of any stripe, be they politicians, artists or journalists. I also have my principles and prejudices, but I do try to keep my mind open and my facts straight.

Forgive me for blowing off some steam, but this article made my head boil. Yes, it's from the Nation, a decidedly left-wing magazine. However, this is no excuse for doing lousy journalism.

The author slams pro U.S. baseball teams who run academies for talented Dominican kids for luring with promises of fame and riches, only to leave most of them penniless and without an education.

Yet, he never really talks to anyone directly involved: the managers of these baseball academies, the kids living there or their parents. Curiously, he never even investigates or actually affirms in black and white that the academies don't provide any education, while admitting that they do provide decent room and board and benefits such as English lessons.

It gets worse. If nearly all or even most Dominican kids had decent educational opportunities, the author's main premise might have made sense. After all, the expected lifetime income of a high school graduate is probably higher than the expected income of a person who drops out of school to pursue the 1/1000 chance of becoming a pro baseball player. However, most Dominican kids don't have that opportunity. According to UNESCO, only 31% of Dominican boys are enrolled in secondary schools (probably of very poor quality).

Given this grim reality, attending a baseball academy is probably the best rational choice for these kids. Not that we'll ever know form journalistic merde such as this piece.

Back again

Sorry for disappearing for a few months. The aliens conclded in the end that I was one sorry human specimen and decided that no further testing was necessary. So, given that I'll stay earthbound, might as well keep up the ol'blog. Thanks for stopping by.